IMF researchers pitch pan-Caribbean 'bad bank'

The authors of an IMF working paper are advocating for a 'pan-Caribbean market' for non-performing loans, or NPLs, to reduce distressed assets in banks across the region.

The paper indicated that the average NPL ratio across the Caribbean is high at above five per cent of total loans, or slightly above regulated norms, while most other regions in the world are tracking lower.

It follows on from the global financial crisis a decade earlier, which triggered macroeconomic instability and business downturn, leading to unserviced debt.

The authors of the working paper Kimberly Beaton, Thomas Dowling, Dmitriy Kovtun, Franz Loyola, Alla Myrvoda, Joel Okwuokei, Inci Otker, and Jarkko Turunen argue that the creation of a regional asset management company, an AMC, would redound to the benefit of the region and free the banks from having to pursue defaulting borrowers.

"The small size of the Caribbean economies, as well as structural obstacles such as gaps in the information framework and cultural and social factors, prevent development of a well-functioning domestic market for distressed assets to facilitate the disposal of NPLs," they noted in the paper titled Problem Loans in the Caribbean: Determinants, Impact and Strategies for Resolution.

But university-based think tank Caribbean Policy Research Institute, CaPRI, is arguing that such a 'bad bank' would prove difficult to set up and was unnecessary at this stage.

"A 'bad bank' makes sense if the banks in a country are insolvent. But that is not currently the situation, so the bad bank question may not arise," said CaPRI executive director Dr Damien King, in response to Gleaner Business queries about the proposal.

Working papers are described by the International Monetary Fund as research in progress, and do not necessarily represent the policy position of the multilateral institution.

The AMC paper did not explore how such an entity would operate logistically, or its governance structure. Rather, it explored the argument that such an entity could offer value.

The structure, as proposed, would allow separation of good assets from bad and free the banks to focus on new and existing loans, while the AMC would focus on recovering the distressed assets.

But King, an economist, was sceptical that a pan-Caribbean operation could work. He reasoned that bad banks are usually public entities, since they often buy bad debts at above market value.

"And that means they cannot be regional since the countries are sovereign," he said.

King also queried whether a regional bank would really help a struggling financial entity to survive, while noting that that would be determined by how the bad bank is set up.

"If the bad bank buys the bad debts at market value, then the private banks are forced to realise and book their poorly-performing assets at their true value, which may compromise their solvency. If the bad bank buys the debt at an inflated value, often the case, then the private banks are better off," said the economist.

The IMF paper argues that the AMC would enable more efficient collection and disposal of distressed assets, and help maximise the value of impaired assets in the banking system.

Few banks in the Caribbean are operating with NPLs below regulatory levels of 5.0 per cent, except those operating in Jamaica and Trinidad & Tobago, according to the IMF authors.

"NPLs have risen sharply across the Caribbean following the global financial crisis. Banking systems in many countries have been plagued by high ratios of NPLs, which, except in Jamaica and Trinidad & Tobago, exceed prudential norms, typically around 5.0 per cent," they said.

In Jamaica, NPLs currently hover at 2.7 per cent of total loans. During the global crisis, NPLs in Jamaica hit a high of 8.4 per cent of total loans in June 2011.

Private and public AMCs already exist, and are met with varying degrees of success.

In an IMF survey quoted by the authors, some 26 of 35 banks in the region indicated that they disposed of NPLs in their NPL portfolio over a two-year period.

"A large majority of Caribbean banks that responded to the IMF survey argue that banks can set up private AMCs and that indeed there are active AMCs operating in their countries. At the same time, there are few examples of operational public AMCs," stated the IMF working paper, which cited the eastern Caribbean and Bahamas as prime examples of jurisdictions that operate public AMCs.

Examples of public AMCs include Financial Sector Adjustment Company, set up by Jamaica in the 1990s to rescue its financial sector, while Eastern Caribbean Central Bank created its own, called the Eastern Caribbean Asset Management Company, to handle private sector NPLs.